There is no greater challenge to neoclassical labor market theory than the existence, and persistence, of downward wage rigidity and its resultant unemployment. In recent years, efforts to explain wage rigidity have focused on implicit contracting, but these explanations pertain most credibly to employment in large firms. Theories of unemployment have stressed variations of the "natural rate" hypothesis, which implies an equilibrium rate to which the economy will eventually return if a perturbation takes place--an implication that seems contradicted by the European experience of the last decade or so. In this little book of three public lectures, Nobel Laureate Robert Solow puts forth a more comprehensive theory of downward wage rigidity, which applies to all labor markets and implies multiple equilibrium levels of unemployment.

Laying out the key concepts underlying his theory is Solow's task in his first lecture (Chapter 1). Employees have a strong desire to be treated "fairly." Wages are a mark of social status and self-esteem, and workers firmly believe that the wage they receive (or a higher one) is richly deserved. When times are good they expect wage increases to be granted ungrudgingly, and when times are bad they believe employers should share (probably disproportionately) in the pain. Because worker effort is so variable, is such an important component of the overall labor input, and is dependent on workers' perceptions of being treated "fairly," the price of labor becomes more than a dependent variable to be determined by the impersonal forces of demand and supply. Instead, both the level of wages and the process by which wages are determined are important factors in the production function. Solow concludes that the conventional model of demand and supply must be altered to incorporate and explain norms of behavior (or fairness) that distinguish the labor market from other markets.

In Chapter 2, Solow attempts to explain a curious norm of labor market behavior: unemployed workers do not even try to undercut the wages of employed workers in order to find or create jobs for themselves. Why are workers more willing to face unemployment than a reduced wage, and what accounts for the social opprobrium associated with wage-cutting? Solow's answer is rooted in an application of the "prisoner's dilemma."

Simply put, this dilemma can be described as follows: in a single-game context it might be rational for the unemployed to try to bid down wages in order to secure employment. In a repeated-game setting, however, signaling a willingness to work for less will reveal. to employers that workers' (common) reservation wage is really below the prevailing level, and employers will permanently cut wages. Only through cooperation or "solidarity," as embodied in the social norm against wage-cutting, can workers avoid both the process and the lower-wage consequences of nasty, brutish, "Hobbeslan" competition in the labor market. Because the prevailing wage, whatever it is, becomes the "floor" that is revealed to employers, persistent unemployment is consistent with many different wage levels.

Solow's final chapter is devoted to the policy implications of a labor market characterized by downward wage rigidity and permanent unemployment. The way to expand employment opportunities, Solow suggests, is to give a greater voice to "outsiders" in the collective bargaining process. He also suggests that group-based pay schemes might replace efficiency wages as a means of eliciting (and monitoring) worker effort. Although he casts an approving glance at Martin Weitzman's idea of widespread profit sharing to help stabilize employment over the business cycle, he warns that an implication of the conditions he describes in the first two chapters is that policies to encourage wage flexibility might make workers worse off.

What are we economists to make of Solow's model? Solow's description of the labor market sounds vaguely similar to the more radical views associated with proponents of the "monopoly power" models of discrimination. After all, if 100 million workers can collude, through behavioral norms, to hide their true reservation wage, why can't four million employers? Wage determination thus becomes, by implication, the outcome of a bargaining process in which attempts are made to divide and conquer, bluff, and punish defectors.

Thinking of wages as the outcome of bargaining by bilateral monopolists has the advantage of according well with the descriptions of institutionalists and the practices of human resource professionals. This view, however, has two flaws. First, it implicitly applies only to the relationship of workers with existing employers. But why couldn't clever new employers offer essentially the same jobs, with new titles and lower wages? Couldn't workers accept these new jobs without violating the collusive norm?

Second, there is the inevitable problem of defection. Perhaps because it is so difficult to point to very many cases of defector punishment, except in increasingly rare cases of anti-scab activities by labor unions, Solow argues that workers refrain from wage-cutting because they realize that their (individual) short-term employment gains will be offset by (individual) longer-term wage losses. Interestingly, this line of reasoning is the obverse of that usually employed by economists. For example, in theorizing about how excess profits affect resource allocation in a market economy, economists emphasize the dominant attraction of short-run gains in competitive markets even though a "rational expectation" is of zero profits in the long run!

In sum, Solow maintains that his model is a mere alteration of the conventional labor market model, but in fact it has the earmarks of a very significant departure from the conventional model. Economists generally believe conventional theories explain the long run correctly, but they have increasingly focused on altering the theory to account for empirical anomalies that have heretofore been dismissed as short-run aberrations. What this book intimates is that the "modern" alterations of labor market theory may bring us closer to the older institutionalist views that characterized labor economics when it first emerged as a distinct field.